Ares Commercial Real Estate Corp. — FY2020 Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2020; filed February 18, 2021. Ares Commercial Real Estate Corporation is an externally managed REIT focused primarily on originating and investing in commercial real estate loans and related investments. The company has no employees and is managed by Ares Commercial Real Estate Management LLC, an Ares Management affiliate.
Business context and portfolio
- Target assets include senior mortgage loans, subordinated debt, preferred equity, mezzanine loans and other commercial real estate investments.
- At year-end, the loan portfolio consisted of 50 loans with $1.826 billion of outstanding principal and $1.815 billion of carrying value before the CECL reserve.
- Senior mortgage loans represented $1.724 billion of outstanding principal; subordinated debt and preferred equity represented $102.6 million.
- Weighted-average unleveraged effective yield was 6.3%, with a weighted-average remaining life of 1.2 years. Approximately 95.3% of loans had LIBOR floors averaging 1.73%.
- The company also owned a hotel acquired through a 2019 deed-in-lieu-of-foreclosure transaction; real estate owned was carried at $37.3 million at year-end.
Financial performance and key metrics
| Metric | 2020 | 2019 | Change |
|---|---|---|---|
| Total revenue | $82.7 million | $77.3 million | Up $5.4 million |
| Net interest margin | $69.1 million | $52.2 million | Up $16.9 million |
| Total expenses | $36.3 million | $39.8 million | Down $3.4 million |
| CECL provision | $20.2 million | — | New in 2020 |
| Realized losses on loans sold | $4.0 million | — | New in 2020 |
| Net income attributable to common stockholders | $21.8 million | $37.0 million | Down $15.2 million |
| Basic EPS | $0.66 | $1.29 | Down $0.63 |
- Interest income increased to $121.1 million from $114.8 million, while interest expense declined to $51.9 million from $62.6 million. Management attributed the higher net interest margin to larger earning assets, increased borrowings and the benefit of LIBOR floors as LIBOR declined.
- Revenue from real estate owned fell to $13.6 million from $25.1 million because COVID-19 materially reduced hotel occupancy and revenue. Related expenses fell to $18.1 million from $23.0 million.
- The company adopted the current expected credit loss standard on January 1, 2020. The year-end CECL reserve totaled $25.2 million, consisting of $23.6 million for funded loan balances and $1.6 million for unfunded commitments. Adoption reduced retained earnings by $5.1 million.
- Net interest margin as a percentage of total revenue was approximately 83.6% in 2020, compared with approximately 67.6% in 2019; this derived ratio reflects the company’s reported revenue and net interest margin.
Cash flow, liquidity and capitalization
- Net cash provided by operating activities was $31.8 million, compared with $32.5 million in 2019.
- Investing activities used $81.9 million, primarily reflecting loan originations and fundings exceeding principal repayments and loan-sale proceeds.
- Financing activities provided $119.2 million, including $73.2 million from common stock issuance, partially offset by $42.8 million of dividends paid and debt repayments.
- Cash, cash equivalents and restricted cash increased by $69.1 million to $74.8 million at year-end. The filing separately states that unrestricted cash was approximately $88 million as of February 16, 2021.
- Stockholders’ equity increased to $473.0 million from $426.3 million, principally because of the January 2020 equity offering, partly offset by dividends, CECL adoption and lower earnings.
- Financing Agreements outstanding totaled $928.7 million at year-end, comprising $755.6 million of secured funding agreements, $63.1 million of notes payable and a $110.0 million secured term loan.
- Including the $443.9 million CLO securitization debt and $59.8 million of secured borrowings, reported debt liabilities were approximately $1.43 billion, excluding other liabilities.
- The company reported compliance with all financial covenants at December 31, 2020. Contractual obligations included $1.116 billion of financing obligations and future loan-funding commitments, including $187.8 million of unfunded loan commitments.
- Quarterly cash dividends remained $0.33 per share during 2020, or $1.32 per share for the year. The company declared a $0.33 per-share first-quarter 2021 dividend plus a $0.02 supplemental dividend.
Material changes versus the prior comparable period
- Loan carrying value increased 7.9% to $1.815 billion from $1.682 billion, while outstanding principal increased to $1.826 billion from $1.693 billion.
- The portfolio expanded through $538.3 million of funded principal, offset by $304.0 million of repayments and $101.0 million of loan sales.
- Three loans with aggregate outstanding principal of $101.0 million were sold at an aggregate realized loss of $4.0 million.
- Three loans with a $67.1 million carrying value were placed on non-accrual status because of COVID-19 impacts; no loans were on non-accrual status at December 31, 2019. The filing also states that loans were paying in accordance with contractual terms at year-end.
- The company issued 4.6 million common shares in January 2020 for approximately $72.9 million of net proceeds.
- The BAML Facility and U.S. Bank Facility were repaid and not extended. The company added a $150 million Morgan Stanley Facility, amended the Wells Fargo and MetLife facilities, and extended the Secured Term Loan to December 2021.
- Management made 11 loan modifications covering $494.8 million of principal, including interest deferrals, maturity extensions, covenant waivers and changes to funding or performance requirements.
Outlook, risks and unusual items
- Management described demand for customized, shorter-duration and often floating-rate CRE loans as a continuing market opportunity, but provided no formal earnings or dividend guidance.
- COVID-19 remains the principal near-term risk. Hospitality, student housing, retail and other affected property sectors may experience lower cash flows, borrower defaults, delayed business plans, collateral-value declines and additional loan modifications.
- Margin calls, collateral requirements, cross-default provisions and refinancing risk could pressure liquidity. The company may need to raise capital, sell assets, reduce or suspend dividends, or issue stock-based distributions.
- LIBOR transition risk is material: approximately $1.8 billion of floating-rate investments and $1.2 billion of floating-rate debt had maturities extending beyond 2021 and were tied to LIBOR. The filing states that the financial impact of replacement reference rates cannot yet be reasonably estimated.
- The company retains first-loss exposure in its CLO securitization. The year-end CLO had $443.9 million of carrying debt and the company’s maximum stated exposure was $111.4 million. A new FL4 CLO securitization closed in January 2021 with approximately $603.0 million of notes and $64.3 million of preferred equity; the company retained approximately $126.8 million.
- The externally managed structure creates related-party and allocation conflicts. In 2020, the company incurred $11.9 million of affiliate costs, including $7.3 million of management fees, $0.8 million of incentive fees and $3.7 million of reimbursed general and administrative expenses.
- The company must maintain REIT qualification and its exemption from Investment Company Act registration. Failure could result in corporate-level taxes, forced asset sales, operational restrictions and reduced distributions.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. The critical audit matter was the subjectivity of the CECL reserve.
Investor verification checklist
- Verify the composition, risk ratings, collateral values and repayment status of the three non-accrual loans totaling $67.1 million.
- Assess whether the $25.2 million CECL reserve adequately reflects COVID-19, property-level deterioration and future refinancing risk.
- Review 2021 and later maturities, extension conditions, covenant headroom and potential margin-call exposure.
- Evaluate the company’s first-loss exposure and overcollateralization tests in the existing and newly issued CLO securitizations.
- Monitor the LIBOR replacement provisions in both loan and financing agreements and any resulting asset-liability mismatch.
- Compare dividends with recurring operating cash flow and taxable income; 2020 distributions exceeded operating cash flow and GAAP net income.
- Review related-party loan purchases from the Ares Warehouse Vehicle, co-investments, management fees and expense-allocation practices.